Term
Secondary insolvency
When a company cannot pay its debts because its own customers do not pay it. It spreads through supply chains, and partner checks, advance payments, credit insurance and swift debt collection protect against it.
Updated
What it means
Secondary insolvency is when a company cannot pay its debts because its own customers have not paid it. The company itself may be healthy and profitable, but its money is tied up in receivables, and when a large customer fails to pay, there is not enough for wages, taxes or suppliers.
It spreads through supply chains like dominoes. The failure of one large customer can cause problems for dozens of smaller suppliers, who then fail to pay their own suppliers. It is typical of construction, agriculture and large contracts with long payment terms.
If it lasts, secondary insolvency can turn into genuine insolvency, when a company cannot meet obligations to several creditors more than 30 days past due. Directors then have a duty to address the situation and file for bankruptcy.
How it works in practice
Prevention starts with choosing partners. Checking creditworthiness in registers and financial statements, advance payments from new customers, limits on open receivables per customer and retention of title to goods reduce the risk that one partner's default will endanger the company.
Trade credit insurance covers the loss if a customer does not pay, and factoring turns receivables into cash before the customer pays. Both cost money, but for key customers they can save cash flow.
Prompt debt collection matters: a reminder right after the due date, a phone call, stopping further deliveries and, if nothing happens, a payment order. The longer a debt remains unpaid, the smaller the chance of recovering it in full.
What to watch out for
Secondary insolvency does not relieve directors of responsibility. Even if the company is not to blame, they must monitor whether it is insolvent and act in time, or they risk liability to creditors. Preventive restructuring may help.
When negotiating deferrals with your own creditors, it is better to be open and propose a repayment schedule than to stay silent. Deferrals or instalments are available for taxes and contributions, but they must be requested in time, before penalties and enforcement begin.
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